The Sensex & Nifty are down sharply by over 2% today, after climbing to record highs in January 2018. The markets are correcting due to 5 primary reasons including reasons such as expected rise in bond yields in the US, global risk aversion, introduction of the long term capital gains tax in the 2018-19 Budget, rise in the volatility associated with equities and the benchmark indices rallying ahead of fundamentals over the last one year.
The above factors are driving equities to lower levels and weak sentiments could play out for a while longer. We do not see a long lasting correction in markets as the primary drivers of equity markets, which are corporate earnings and economic growth are expected to come in stronger both in domestic and global markets. Click here for our presentation on Sensex 40 in 2018.
However, Investors should be cautious in investments in equities and should understand what they own.
As far as our clients are concerned, we closely analyse the stocks that we have recommended for your portfolio and the results have been in line with our own estimates and we are positive on the stocks over a longer period of time.
Factors that are contributing to the downturn in equities and their implications –
Rise in Bond Yields in the US
Global equities have exhibited some nervousness in the past few days after yields on the benchmark 10 year U.S. Treasury reached levels not seen in almost four years. This comes as the Federal Reserve continues its tightening following years of accommodative policy and investors anticipate a pickup in inflation. Rising bond yields are traditionally seen as bad for stocks as it means large companies will have to spend more to finance their debts as interest rates increase. The Federal Reserve remains on track to raise interest rates at least three times in the year 2018 and that is the reason why the trend is likely to continue for some time. The U.S. 10-year Treasury yield briefly rose to around 2.75 % following the release of the Fed statement and remained around its highest level in nearly four years.
Global Risk Aversion
The movement of the USD against the Japanese Yen indicates global risk aversion. The Japanese Yen has appreciated 3% against the USD in the month of January 2018. Similarly the Euro has appreciated 3.6% against the USD in the month of January 2018.The dollar failed to draw much support from higher Treasury yields as the risk-averse mood favored its peers like the yen and the euro.
Rally in the Sensex and Nifty in the year 2017
The Sensex and the Nifty have rallied by 27% each and the small cap and midcap indexes have rallied by 35% and 27% respectively in the calendar year 2017. The sharp run in the large cap, midcap and small cap indices was on account of positive macroeconomic developments followed by large inflow of funds from domestic institutions. The large inflow of funds from domestic institutions was mainly due to investors shifting to equities from low yielding bank deposits on the back of declining interest rates. FII’s too have pumped in money into equities on the back of a global rally in equities that have taken indices across the globe to record highs.
The excess liquidity that drove the benchmark indices to record high levels exceeded the fundamental growth in earnings of companies (earnings per share growth). The Sensex and the Nifty price to earnings ratio reached levels of 26 and 28 respectively when the indices rose to record high levels in the month of January 2018.
Introduction of the long term capital gains tax in the 2018-19 Budget
The Government introduced a tax for long term capital gains exceeding Rs.0.1 million at the rate of 10% without allowing the benefit of any indexation for equities in the recently announced budget.
The introduction of the long term capital gains tax for equities was a dampener for the markets as it was originally not being taxed to encourage long term investments in an emerging economy like India.
The deadline for the long term capital gains not getting taxed is 31st March 2018 (assumed) and the markets would witness selling pressure till that time if investors continue to take the benefit.
Rise in Volatility
India Volatility Index measures the degree of volatility or fluctuation that active traders expect in the Nifty50 over the next 30 days. It represents the expected annualized change in the Nifty50 over the next 30 days. To simplify, a VIX of 12 means that, for the next one month, market participants expect the Nifty to move by an annualized rate of 12 per cent in either direction.
The India VIX which is currently is calculated to be 14.62 (2nd February 2018) had reached levels of 18.49 in the month of January 2018. Historical data from 2009 tells us that the high points for the VIX was at 55-57 levels in April-May 2009. Its life low was made quite recently, in June 2017 at 8.75. In the last 52 weeks, the VIX has stayed in a band between 8.75 and 23.09.
In a Bull Run in Equity Markets, Investors are constantly told about the returns they can make from investments with past returns used as a primary example. The downside of Bull Market Investing is pushed to a corner as Risk Factors. In fact, Risk Factors should figure prominently in Bull Markets as Time and Again over centuries, majority of investors lose money in bull markets.
Investor behaviour is pointing to higher risks. First time investors are investing without understanding the risks in equities, speculators are leveraging heavily and caution is being thrown to the winds by many others. Price movements of stocks also suggest excessive speculation with many stock prices rising multifold in a very short span of time. As prices rise fast, valuations rise sharply and if earnings or growth do not meet expectations, prices will fall sharply from highs.
Arjun Parthasarathy, Founder InvestorsAreIdiots.com will be holding a session with investors on 16th February at Sofitel BKC on a Bull Market Topic that you do not want to hear. Join him over a cup of coffee to know all the insider info on the world of Bull Market Investing
Day and Date: Friday, 16th February 2018
Venue: Sofitel, BKC, Mumbai
Time: 3:00 pm to 6:00 pm